1. he timing of investment decision making has
never been more important than it is now
given the recent Euro correction, the trouble
with both the Greek balance of payments and the
debt to GDP ratio, as well as the threat to the system
from other peripheral European countries. Recent
events have shown us that during extreme market
shocks portfolio diversification doesn’t work as theory
would suggest due to the increased correlation of risk
assets. This has happened in fixed income with bund
and Treasuries contracts and may even happen with
gold prices at some point. Going forward, the biggest
concern among economists and investors is what
plays out in three areas: 1) price inflation or deflation;
2) acceleration or stagnation of economic growth; and
3) emerging markets versus developed economies.
The resolution of each of these concerns will be
considerably impacted by the huge liquidity available.
Cash sitting on the sidelines may be kept there owing
to market volatility. Yet after any major fall in equities
prices, liquidity is there to push the market up,
perhaps leading to opportunistic bids for companies
as investors look to put money to work.
Risk has been transferred from troubled banks to
government balance sheets. This has contributed to a
generally low interest rate environment which could
persist for some years to come. Unusually, companies
that restructured or refinanced their balance sheets
in the last few years have healthier debt ratios than
some governments, particularly in Europe.
When Xenfin Capital was set up by Duncan MacInnes
it sought to trade the small trends in foreign
exchange markets on a daily basis. Our core model is
a systematic approach that covers the G5 currencies.
The model contains 10 separate time tested sub-
strategies and each model is not correlated within the
basket. The strategy is particularly profitable in both
directional and non-directional markets, having the
advantage of not taking longer term market views,
and in consequence avoiding longer term decisions in
what are likely to be very crowded markets.
Euro downside may grow
One natural trade for Xenfin to focus on is €-$. After
sharp falls the euro has partially rebounded but that
may not go on indefinitely. We believe that the euro
will have much more downside in 2011 than in 2010 if
the Fed tightens rates and the European Central Bank
(ECB) is forced to stay on the sidelines to facilitate
economic growth. Therefore, if the move to parity or
1.10 for the euro is delayed to 2011, it isn’t difficult
to see €-$ trading around the current rate of 1.20
into the yearend. If the €-$ cross remains around the
current rate, it will be interesting to see how this
affects the development of the euro as a funding
currency for carry trades using high yield currencies
from emerging markets or the Australian and
Canadian dollars. Of course, this favourable outcome
for the euro is subject to European authorities
approving and delivering support to member states.
It also requires the European political response to be
well coordinated, otherwise the future of the euro as
well as the stock and credit markets will be dark.
The allocation of the three month repo operation
by the ECB was key for the markets, regardless of
the outcome sentiment could be viewed positively
or negatively. In fact, corporates have been using
alternative routes to funding directly with banks. The
recent announcement by Siemens AG to apply for a
bank licence in Germany is significant. Is the finance
department of this large international conglomerate
looking for alternative ways to lease products to
end customers, or is it a way to ask directly to the
Bundesbank for cheap funding and repo lines?
Additionally, either a small or a large drawdown on
the repo operation will be particularly supportive
for the euro, as traders and economists will remain
worried about the liquidity of the banking system,
the sovereign funding ability, the balance sheet of
the so called Club Med countries. Notwithstanding
unprecedented levels of fiscal intervention to help
the economy and moves to regulate investment
banks and hedge funds through tax levies, the credit
markets still remain mostly shut, not only for the
general public but for most institutions.
Chinese equities correlation
A very interesting phenomenon is how Chinese
equities correlate to world equity markets. When
the A or H share indexes tank, it is generally the case
that other major equities markets slip into negative
territory. However, on a total return basis, some
economists are finding that US and European equities
are more correlated to each other than with equities
in China. What happens then if the Chinese left hand
side engine of the plane is not exporting to the US
right hand side engine because of stronger yuan
appreciation? There seems to be little knowledge
about how this would play out or what the authorities
in China might do.
The degree to which decoupling between credits
and stocks happens will continue to be driven by
the perceptions of event risk and economic risk. The
correlation will remain high if attention continues
to focus on event risk. However, if the market focus
returns to concerns that growth will be anaemic then
credit will probably outperform stocks. Companies
with US investment grade credit ratings have already
built massive amounts of liquidity at cheap rates as
well as levels of capital and reserves well above the
levels before the credit crisis began in 2008. Capex
will be saved, and falling T-bond yields will remain
supportive for corporate credit spreads and yields. It
means that the downside in credit spreads is probably
limited at the current juncture and well below the
equity risk and volatility. THFJ
Timing Investment Decisions
Increased correlation occurs despite diversification
LUCA RUBINELLI, PORTFOLIO MANAGER, XENFIN CAPITAL
T
ABOUT THE AUTHOR
LUCA RUBINELLI
Luca Rubinelli recently joined Xenfin Capital to run
their Global Macro ART strategy. Using a top down
approach, the proprietary trading strategy filters
daily and intraday signals of the most liquid ETFs.
Fig.1 Comparitive Absolute Return Source: Xenfin
200%
150%
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0%
-50%
-100%
Jan05
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Xenfin
CS Tremont Index
Barclay CTA Index
MSCI World
EUR/USD
1
September 2010
FINAL